According to the “flying-geese” theory of growth for East Asian economies, the natural complementary nature of India and China — a result of their different stages of industrial development — could have been a viable pathway for India to thrive. However, since the conflict in the Galwan Valley in 2020, the Indian government has increasingly focused on seeking industrial substitutes for China, regarding the move as a critical part of its “Make in India” campaign.
The Indian substitution policy includes five main elements: tightened visa rules, tax probes, investment restrictions, tariff adjustments and subsidies.
First, the Indian government has markedly tightened work and business visa requirements for Chinese employees who hold hold critical positions in Chinese companies operating in India. However, Chinese enterprises that help improve and strengthen the Indian industrial chain, that have joint ventures with Indian or Western companies or that are willing to share industrial technologies with India are not restricted in this regard. The stricter visa policy has seriously degraded the living and operating environment for Chinese businesses in industries where Indian companies also operate, such as smartphones, engineering contracting and telecommunications.
Second, tax probes into Chinese enterprises in India are conducted at will. Theoretically, those are not targeted at any particular nationality, but in recent years Chinese businesses have been increasingly subject to tax inspections. The sheer number of tax agencies in India is already beyond the affordability of Chinese enterprises. They include four law enforcement agencies at the federal level, including provincial branches:
• the Directorate of Revenue Intelligence (DRI) under the finance ministry, the top organ of Indian Customs against smuggling and tax evasion;
• the Directorate of Enforcement (ED), which is responsible for money laundering investigations;
• the Income Tax Department (IT), which focuses on illegal profit transfers; and
• the Customs Special Investigation and Intelligence Branch (SIIB), which specializes in fraud, false statements and tax evasion cases.
India’s tax policies are designed with obvious ambiguities, lags and policy imbalances (or even conflicts) between tax inspection agencies and investment promotion departments. As a result, there are a variety of options for Chinese-funded enterprises to access the Indian market and operate in compliance, as well as much room for maneuvering by tax agencies seeking tax inspections.
Since China-India relations deteriorated, “flaws in compliance” that were accommodated when Chinese companies entered the Indian market have not only invited tax audits and fines but also gave a ready excuse to the Modi government to implement its industrial substitution strategy. Some Chinese enterprises have had to suspend production or even close down. Smartphone brands, for example, have been the subject of frequent tax inspections in India.
Third, since the conflict in the Galwan Valley erupted in April 2020, the Modi government has revised a series of policies and regulations designed not only to restrict future Chinese investments but also to reduce existing investments. It has launched a so-called trust list on grounds of national security, rejecting Chinese investments in India to the maximum extent possible, excluding Chinese companies from the bidding process (for government projects in particular) and seriously reducing the future living space of Chinese enterprises with regard to transportation, communication, energy and other engineering contracts in India. Those already operating will have to change their main business or exit the Indian market after completing the projects at hand.
Fourth, import tariffs on goods have been increased to force the industrial chain in China to relocate to India or establish joint ventures in the country, thus achieving the localization of Make in India.
At the center of this policy, the Indian government will gradually restrict the importation of critical components and spare parts for end products, localize their production and ultimately put in place closed-loop industrial chains by imposing higher import tariffs in a phased manner. With the artificially created — and huge — cost differences between locally assembled or produced end products and imported ones, international manufacturers under pressure have not only invested in building assembly plants in India but also moved manufacturing factories of spare parts there with higher added value in the upstream industrial chain.
The Modi government tested the strategy with smartphones and achieved remarkable results. From the assembly of the whole machine to generic parts and even high-value accessories, India now has a roughly complete production and supply chain for smartphones (except for chips and batteries). This is evidenced by the mass production of iPhone14 and iPhone 15 models in India. Encouraged, the Modi government plans to replicate the successful model in more labor-intensive industries such as televisions, microwave ovens, digital cameras and even furniture and toys.
Fifth, after Galwan Valley, the Modi government launched its “production-linked incentive” scheme, focusing on enhancing Make in India capacity through financial subsidies and giving priority to encouraging industries with existing production capacity to strengthen local manufacturing. The 14 industries in the financial subsidy plan coincide largely with current Indian imports from China. Obviously, the tightly targeted scheme is designed to reduce dependence on Chinese industries and accelerate the Make in India campaign. It has seen remarkable results in smartphones, pharmaceuticals and new-energy vehicles.
The worsening of relations with China is the underlying factor behind India’s desire to accelerate industrial substitution with respect to China. In other words, the security logic has superseded the market logic. Since Galwan, any and all bilateral issues have been turned into matters of security at will. This has changed the mode of China-India industrial interaction from being mutually complementary to India “crossing the river by touching China”.
In addition, the Modi government increasingly believes that Indian manufacturing will rise only when the country eliminates the presence of China in its own industries. On one hand, industrial substitution is the only way for India to rejuvenate itself through industry. China enjoys industrial clusters and cost advantages as a result of complete industrial chains at home. If India does not decouple from China, the laws of the market will not allow it to achieve industrial self-reliance. On the other hand, at the center of the West’s goal of reconstructing globalization is an effort to reduce China’s footprint and reshaping global industrial cooperation to replace the United States and the “West plus China” model in the past 30 years. India is the only economy in the world that is in a position to take up the role of a super substitute.
Given the huge size of the Indian economy and its relatively complete industrial sectors, the policy and practice of industrial substitution is bound to have an impact on China’s industrial development. China must deal with this effectively by further strengthening its own industrial and innovation chains —especially via improved industrial clusters and whole-industrial-chain cost advantage through application of intelligent, digital and automation technologies. It must also improve its policy on industrial chain transfers — to India in particular — so as to avoid contributing to India’s development at the cost of China’s development.